Can a Prop firm issue a 1099 without being a Broker-Dealer?

aeliodon · Nov 7, 2007

I heard from a trader that trades with Avatar (LLC within Assent) - that they issue a 1099 Schedule C
and I thought only brokers can issue 1099? I thought the usual approach for prop firms was a K-1.

http://kb.taxslayer.com/article.php?id=313
http://www.irs.gov/charities/article/0,,id=131138,00.html

from greentrader website:

Here are the current business models and how they may be changed by regulators
Note that regulators have been forcing other changes on this industry for many years, but these new changes appear to be much more fundamental with potentially drastic consequences.

Employment model: All or some of the prop traders can be employees of the firm and receive IRS Form W-2 (wages).

The employee model appears to continue to pass muster with the regulators, but deposits from prop traders may no longer be allowed (again, on a case-by-case basis during regulatory audit or enforcement proceedings).

Now we will see how many firms are truly offering âjobsâ (with W-2s) to traders. In the past, we pointed out that some job ads were really âcome-onsâ to attract deposits and earn commissions and other fees for the firms.

LLC K-1 model: All or some of the prop day traders are LLC members of the LLC prop day-trading firm and receive a Schedule K-1 (share of partnership income) based on âspecial allocationsâ of their specific trading profits in the firm.

Management of the firm (the true owners) own Class A shares, and prop traders own a lower class, like B, C or D. Only Class-A members share in firm-wide profits.

Regulators may only allow this LLC K-1 model going forward if the firm allocates profits to members on a firm-wide basis and doesnât bar the prop trader classes from sharing in these profits.

This apparent new requirement could render this LLC K-1 model unattractive to both firms and trader alike. Firms may not want to share commissions and other profits with prop trader LLC members, and the prop traders may not want to risk sharing in losses caused by other traders in the firm.

This LLC K-1 model has been the most prevalent for larger prop day-trading firms, so we are concerned about how regulatory enforcement actions might upset the industry in this regard.

Independent contractor model: All or some of the traders are independent contractors and receive IRS Form 1099-Misc. (with Non-Employee compensation or Other Income boxes checked).

Regulators apparently donât want these relationships at all going forward. Most broker/dealers went away from this model, but smaller boutique non-broker/dealer LLCs use it. Again, no deposits will be allowed.

Non-broker/dealer prop trading firms
The industry has also grown a branch of smaller boutique prop trading firms that are not broker/dealers. These smaller LLCs recruit prop traders who are not licensed brokers and allow lower deposit requirements; usually $3,000 to $10,000.

These smaller firms fly below the regulatorsâ radar screens since they do not file reports required from broker/dealers (FOCUS reports and more). One particular problem for these smaller non-BD firms is that their managers may âquote ratesâ â commissions and transaction costs. Only brokers can quote rates, so this is an illegal activity and the regulators are concerned with it.

Some larger prop day-trading firm broker/dealers utilize many smaller boutique non-broker/dealer LLCs to recruit more trading and business. An entrepreneur prop trading broker in the broker/dealer firm spins off his own âsub-LLCâ to recruit smaller non-broker traders with lower deposit amounts. That broker may quote rates and it can be troublesome.
More...

What are the tax implications of receiving a 1099 Schedule C? Do you have to account for each and every single trade?

Don Bright · Nov 7, 2007

1099 on Schedule C = you pay Self Employment tax. K-1 from LLC, you are exempt from Self-Employment tax. Both ordinary income. No matching of trades that I recall when we issued 1099's.

Another reason our Affiliates don't use Sub-LLC's. Our traders are all members of the main Company, and eligible for the tax benefits. Just FYI.

Don

This is not legal or tax advice, just my personal opinion, not that of Bright Trading or any of it's affiliated entities.

aeliodon · Nov 7, 2007

Is this true of all Assent LLCs? Do they all issue 1099s?

QuantPlus · Nov 7, 2007

I find it shocking that one can run a "prop firm"...
Without being registered as a broker-dealer.

Anyone trader that would put money into such an entity is nuts.

uniquetrades · Nov 8, 2007

why are you shocked about it? they are trading their own capital.

ebayuser · Jan 18, 2008

Quote from Don Bright:

1099 on Schedule C = you pay Self Employment tax. K-1 from LLC, you are exempt from Self-Employment tax. Both ordinary income. No matching of trades that I recall when we issued 1099's.

Another reason our Affiliates don't use Sub-LLC's. Our traders are all members of the main Company, and eligible for the tax benefits. Just FYI.

Don

This is not legal or tax advice, just my personal opinion, not that of Bright Trading or any of it's affiliated entities.
More...

Don,
do you know what the attachment on the K-1 says that makes prop traders exempt from paying self employment tax? has something to do with a mark-market election by the prop house correct?

yip1997 · Jan 18, 2008

Quote from aeliodon:

Is this true of all Assent LLCs? Do they all issue 1099s?
More...

No. Some give 1099 and some K-1.

yip1997 · Jan 18, 2008

Quote from QuantPlus:

I find it shocking that one can run a "prop firm"...
Without being registered as a broker-dealer.

Anyone trader that would put money into such an entity is nuts.
More...

Without being registered as a broker-dealer, their traders don't need register (i.e. no license required).

monstercat · Jan 18, 2008

don your spreading mis information again. your traders have zero tax benefits over any retail are other prop trader who files his returns as a trader in securities. wether you get a 1099 from
a broker are a k-1 or 1099 from a prop house it makes zero difference it what tax writeoffs one can take. all can still do a sch c are in your case you take the traders expenses and give them a net k-1 after expenses i believe. now i don't know why a prop house would issue a 1099 instead of a k-1? is there a tax benefit to them?NOW DON IF YOUR DISTRIBUTING SOME OF THOSE MASSIVE COMMISSION OVERIDES YOU MAKE THEN YOUR TRADERS HAVE A HUGE ADVANTAGE. LOL

ebayuser · Jan 18, 2008

I do believe that prop traders that get a k-1 do get a tax advantage, being exempt from self employment tax, as long as the the prop house makes the election on the k-1 for mark-market accounting. now I could be wrong, but that is what I have heard.